Venture capital funding plummeted in 2012

New data from the venture capital industry put some cold, hard numbers on how tight belts have gotten in startup land.

The new MoneyTree report from the National Venture Capital Association and PricewaterhouseCoopers shows that VCs invested less money in private companies last year than in 2011 -- the first such annual decline in three years.

And venture investors became increasingly cautious as the year went on: In the year's second quarter, with enthusiasm soaring for the initial public offerings of Facebook and LinkedIn, venture funding followed suit.

But Facebook's underwhelming Wall Street debut, combined with ongoing volatility in the broader economy, left 2012 trailing 2011 in the number of tech IPOs and mergers -- the lifeblood of venture investment returns.

Venture funding, not surprisingly, dropped in both the third and fourth quarters, to $6.4 billion in the three-month period that ended in December. That was a 3 percent decline in dollars compared to the third quarter, though deal volume rose 5 percent, with 968 companies funded.

For the year as a whole, venture funds invested $26.5 billion in 3,698 deals. That was a decrease of 10 percent in dollars and a 6 percent drop in deals over 2011.

Still, the president of the venture capital association said he sees reason for optimism in the numbers.

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"Most people would say, 'Oh my gosh, the sky is falling,' " said Mark Heesen. Instead, he believes the tightfisted funding mood -- and an ongoing shrinkage in the number of venture funds -- will lead to "a more disciplined environment. The companies that are going to be funded are going to be really good, and a lot of the 'duplicative' companies aren't going to be funded."

Tracy Lefteroff, who heads the global venture capital practice at PWC, largely agreed. His firm and the venture capital group prepare the MoneyTree report using data from Thomson Reuters.

Lefteroff argues that the hefty venture investing of early last year reflected irrational exuberance over the promise of social media. "If you remember, there were a slew of companies lined up to go public, and that went away very quickly," he said.

Concerns about looming budget battles in Washington, D.C., he noted, also are helping tamp down investor enthusiasm, both among venture capitalists and big Wall Street investors.

Matt Hendrickson, CEO of a San Francisco startup called Ascendify, said the shrinking venture capital pie means more competition among tech fledglings.

"We just have to be that much better in 2013 to secure our next round of funding," said Hendrickson, whose year-old company makes talent-recruitment software for enterprise clients. He's currently raising a seed funding round from angel investors and early stage venture firms, but he's already looking ahead to a larger Series A round a year from now.

Lefteroff said software companies, in fact, are still enjoying favor from venture investors. In 2012, VCs invested more in software deals than at any point since 2001, according to the MoneyTree data.

Capital-intensive biotech and cleantech, on the other hand, were particularly hard hit last year, part of an ongoing trend.

Clean technology saw a 28 percent decrease in dollars and a nearly equal decline in deal volume compared to 2011, the MoneyTree report found. Things were even gloomier in the fourth quarter, when venture capitalists put $535 million into 67 cleantech deals -- a 36 percent drop in dollars from the third quarter.

Venture investments in the life sciences -- including biotechnology and medical devices -- fell 15 percent in 2012, to $4.1 billion. On the bright side, that still represented the year's second largest investment sector in terms of dollars and deals. And life sciences saw an uptick in the fourth quarter.

Lefteroff remains fairly bullish on the life sciences, noting there's still "huge unmet needs" for new therapies. But given the long and often obtuse process for new drugs and devices to receive federal regulatory clearance, pharmaceutical companies and other investors remain conservative, he said.

Cleantech, Lefteroff said, may face an even steeper challenge, given that such companies require vast amounts of cash to grow and that there have been relatively few IPOs or big acquisitions to enable venture investors to reap returns.

"How long can the venture guys continue to fund these companies," he asked, "and who's going to be there to pick up the pieces?"

Heesen agreed that the plunge in cleantech and life-sciences funding is a concern.

"I think you are seeing a change in the market," he said. "You're going to see more deals that sort of work around the edges, as opposed to trying to create a new car company or a new type of energy."

Contact Peter Delevett at 408-271-3638. Follow him at Twitter.com/mercwiretap.